After I wake up, feed my yellow lab and check the internet for updates on Nebraska football, I do two things: 1) help small and medium business owners (especially manufacturers, architects, engineers, computer software and agriculture) keep more of their tax dollars as National Managing Director for alliantgroup; 2) help whistleblowers who want to speak out about fraud involving taxes and government spending at my law firm ZFFJ.
My hope is to comment on tax policy, cutting through the headlines to give business owners a clear sense of what is really going on in DC. I draw on nearly 18 years of government service – including 8 years as Tax Counsel for the Senate Finance Committee when we passed some of the largest tax bills in the history of the country (EGTRA, JEGTRA, Pension Protection Act, Jobs Act, etc.). I try to highlight tax laws and regulations – and especially overlooked provisions -- that can benefit business owners or have an unexpected bite.
That I am the only person who has both a BFA in Film Production and an LL.M. in Tax from NYU (as well as a JD from George Mason) hopefully comes through in my writing as I try to overcome one of the greatest writing challenges – bringing humor to tax.

1/23/2012 @ 11:15AM8,459 views

How To Avoid -- Or Win -- An IRS Audit or Court Battle

The taxpayer advocate’s annual report to Congress was recently released and one of the more useful parts of the report is its rundown of issues that taxpayers and the Internal Revenue Service most frequently end up fighting out in court. This list of top litigation provides a useful window into the IRS’ focus– especially in regards to individuals and small business owners. Here are some of the issues and how you can stay on the right side—or beat—the IRS.

Trade or business expenses. For individuals the problem continues to be having good books and records to support the deduction of expenses – especially for travel and entertainment expenses. The advocate noted that “taxpayers represented by counsel fared noticeably better than their pro se counterparts” (meaning taxpayers who represented themselves, as provided for by U.S. Tax Court procedures.) Taxpayers with representation received full or partial relief in 58 percent of litigated cases vs. just 34 percent for pro se taxpayers. Good to see that law degree is helpful.

A number of cases in this area also get into the question of whether the taxpayer is deducting expenses (and claiming losses) for a legitimate “for profit” activity. As a general rule, I’ve found the IRS takes a dim view of businesses that involve animals – horse training, cat raising, etc. If you aren’t making a profit in your animal business, be ready for an IRS letter, particularly if you are claiming a loss from the activity and deducting as a business expense your subscription to “Cat Fancy” or “Horse and Hound” magazines, as well as the cost of kitty litter, oats, etc. Don’t be surprised if the IRS deems your animal fancy a hobby. (For more advice on what you can and can’t do, see Ten Tips On Deducting Your Hobby, here. )

Gross income – What counts as income. Damage awards top the list here. While payments due to physical injury or sickness are not subject to tax, other damage payments are (ex. payments for emotional distress). The effort to avoid this issue should start by having a tax attorney involved with the final settlement agreement. Always a big help if you ensure that a settlement makes clear what the payments are for. (If you’re involved in litigation, be sure to read the advice on taxation of damages here.)

Discharge of indebtedness is the second issue in the area of gross income – particularly treatment of discharge of indebtedness for a principal residence is something that I’ve seen a good bit of with so many taxpayers suffering in the housing collapse.

Accuracy Related Penalties – Section 6662. In our litigation work, this penalty certainly is a favorite of the IRS. We have found, as the advocate report highlights, that taxpayers have good success in having this penalty set aside by showing that the taxpayer had adequate records and made a reasonable attempt to comply with the requirements of the law.

It is not a helpful story if the taxpayer points to an empty shoe box as holding the justification for the position taken on a return. As the advocate report notes, citing Treasury regulations, it is helpful if the taxpayer can show reliance on a tax professional – so long as the taxpayer provided all necessary information to the tax preparer; the preparer was competent; and, reliance was reasonable.

Claiming that the tax software screwed it up – was not embraced by the tax court in the case Anyika v Commissioner. Back to claiming the dog ate it.

Liens and Summons. In general, lots of taxpayers are litigating and most of them are losing. My suggestion is to move heaven and earth to keep a lien from being filed in the first place. It is the devil to make happen but it can be done.

Joint and Several Liability – Innocent Spouse. An antediluvian issue. The advocate’s report does a good job of highlighting that a key factor for getting relief is whether the spouse claiming innocence knew, or should have known, of the tax deficiency. Under pressure, the IRS has been modifying its policies in this area some.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.